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"The Drunkard's Walk" by Leonard Mlodinow

A look at how randomness rules our lives, including our investments.

A quick glance at the cover of Leonard Mlodinow's "The Drunkard's Walk: How Randomness Rules Our Lives" (Pantheon, 2008) may trick you into thinking it's a self-help book or something related to alcoholic beverages, but it's not. The book's title actually comes from a mathematical term that describes random motion in nature. (Think of the wave patterns created by a large body of water.) And it's this unpredictable randomness, according to the author, that impact things like wine ratings, performance evaluations, political polls, investments and your kid's grades. Whether we realize it or not, randomness or chance plays a large role in our everyday activities.

For example, how was it possible for Roger Maris to hit 61 home runs and beat Babe Ruth's single season home run record back in 1961? Up until that time, Maris had never hit more than 39 home runs in a year. While we can never know for sure if Maris was greater in 1961 than Babe Ruth in other years or just a beneficiary of luck, coin-tossing models very closely match his performance, including both the hot and cold streaks.

Another pestering question is this: Why do people that appear headed for success fail, while others who appear destined to fail, succeed? Mlodinow explores this question by considering what happened to Bill Gates, the founder of Microsoft.

In 1980, as a group of IBM employees were working on a top-secret computer project, they came into contact with a young Gates. IBM needed an operating system for its planned home computer. Gates referred IBM to Digital Research and an agreement between the two companies never amounted to anything. As it turns out, IBM came back to Gates and an agreement to license the DOS (disk operating system) from his small computer firm was struck. Many computer professionals claimed DOS was no better than competing programs like Apple's Macintosh, but Gates still got the deal and from there he built an empire.

Was Gates more brilliant than his peers or did chance crown him? Mlodinow writes: "Had it not been for Digital's uncooperativeness, IBM's lack of vision, or the second encounter between Jack Sams (an IBM employee) and Gates, he might have become just another software developer rather than the richest man in the world."

It's a human tendency to downplay the idea that random factors impact us personally, especially when we think of ourselves as being in the driver's seat. This is especially true of individuals who have achieved fame and fortune. Our perceptions are misleading because we overestimate the degree to which success indicates ability. "We are inclined to see movie stars as more talented than aspiring movie stars and to think that the richest people in the world must also be the smartest," states Mlodinow.

Nowhere is the attribution of genius and success more misleading than on Wall Street.

For 15 straight years, Bill Miller, portfolio manager of the Legg Mason Value Trust, outperformed the S&P 500. Money magazine showered Miller with accolades by calling him "the Greatest Money Manager of the 1990s." Morningstar followed suit by naming Miller "Fund Manager of the Decade" and Smart Money magazine referred to him as one of the top 30 most influential people in investing from 2001 to 2006.

Mlodinow deconstructs Miller's performance as a random streak and not rare genius. He writes: "There were more than 30 12-month periods during his streak in which he lost to the S&P's weighted average, but they weren't calendar years, and the streak was based on the intervals from January 1 to December 31." In a sense, the streak was artificial to begin with and one that by chance was defined in a manner that worked to Miller's favor. Given Miller's recent fall from grace and subsequent market underperformance, the author's point makes sense. Mlodinow provides other compelling mathematical evidence to prove his point.

While we may not necessarily come to the exact same conclusions as the author, The Drunkard's Walk is a must-read and one of the best recent books on randomness and mathematical probability. Unlike most academic work in this area, the book is entertaining and easy to follow. Mlodinow received his doctorate in physics from Berkeley and now teaches about randomness to future experimental scientists at Caltech.